EQUITIES UPDATE: The Indian Banking Sector

Last month, the Finance Minister revealed plans to set up a committee of bankers for resolution of bad debts in banks

The Indian Banking Sector

Last month, Interim Finance Minister Piyush Goyal revealed plans to set up a committee of bankers headed by the Punjab National Bank (PNB) Chairman Sunil Mehta, to examine the viability of setting up of an Asset Reconstruction Company (ARC) and/or Asset Management Company (AMC) for faster resolution of the public-sector banks’ (PSBs) bad debts.

This comes at a time when, despite the government’s efforts to clean-up the PSB balance sheets, they are reporting escalating Non-Performing Assets (NPAs). In the quarter ending March 2018, the 21 state-owned banks held approximately $100bn of bad debt, up around 70% y/y and accounting for the bulk of the record $150 - $180bn of soured loans in 2017.

Also, according to the government auditors, bad loans reported by India’s five biggest state-run banks were about $6.8 billion more than the lenders had originally estimated; prompting these institutions to increase provisioning and take a profit hit during the last reporting season.

The RBI views this problem as getting worse before it gets better. In its most recent Financial Stability Report, they estimated that the Gross NPA/total loan ratio of all commercial banks could rise to 12.2% in the current fiscal year, up from 11.6% reported in March 2018. The assessment noted that 11 state-controlled banks that are under the Prompt Corrective Action (PCA) program are likely to see "a worsening of their GNPA ratio from 21% in March 2018 to 22.3% by this fiscal-end" as tighter provisioning regulations kicks in and pressure builds in the highly indebted power sector.

Despite the deteriorating outlook for asset quality, last week the government announced that it is unlikely to introduce another ARC or “bad bank”; citing a reluctance to allocate more money to the sector and satisfaction with the current workout framework.

Currently, India has 24 ARCs and a new Insolvency and Bankruptcy Code (IBC) that is already working through a large number of workouts. Unfortunately, the ARCs have a poor track record in resolving the high levels of NPAs. According to CreditSights, they only can acquire 3% of bad assets in the system, have a low recovery rate and a long review period. On average, they recover only about 26% of the value of the defaulted loan in about 4.3 years. Also, the government has already made several rounds of pledges for the state-controlled banks, with little to show for it. Last October, the Modi government announced a $32bn capital injection for the sector and $14 billion earlier this year.

At this juncture, it is unclear what else, if anything, the government is going to do for the financial sector. Currently, the Modi government seems to be betting that the capital injections coupled with the IBC process and the economic recovery may be enough for now. Some officials and people in the banking system are more optimistic seeing a peak in the NPA in the coming quarters.

One group of bankruptcy proceedings to watch over the next year is in the thermal power sector. According to a recent Bank of America-Merrill Lynch report, approximately 71 gigawatts (GW) of thermal power capacity, about a quarter of India’s, is stressed. This could imply another $38bn of bad loans for the banks. Efforts by these companies to get an exemption from the RBI on its stricter guidelines have failed.

The VFTP Model Thematic Portfolio has a position in India and in the Indian banks. We believe that the government has shown a strong resolve towards the bad loan problem in forcing stricter provisioning and setting up the IBC workout process. However, it is interesting that the government is showing more hesitation in committing capital to the sector. Most analysts believe that the Mr. Modi needs to allocate at least another $30-50bn to the sector for clean-up. This may be a thorny issue going into next year’s general election and the Prime Minister may be unwilling to commit more taxpayer money before then.